Prepared by:
James C. Smith
Vice President-Regulatory
Ameritech
12/06/95
Good afternoon, and thank you, John for the kind introduction. Ameritech is very pleased to be an active participant in this timely and informative conference. I am grateful for the opportunity to be here and to learn from the outstanding speakers who have preceded me. I have gained some new insights into the complex subject of universal service. And while the speakers have certainly had differing opinions on how universal service goals should be viewed for the future, there seems to be a great deal of common understanding and agreement on how universal service has evolved to its current situation.
At Ameritech, we see the real prospect of imminent competition in nearly all of our markets. Unfortunately, as things currently stand, we also see the very distinct and dangerous possibility that as this competition develops we, and we alone, will continue to be counted on to shoulder the burdens of sustaining current universal service policies in the territories we serve. However, current policies are not sustainable -- the burden is one that my company cannot continue to bear alone as it faces competition throughout our business. Seeing that time is running out on current universal service policies, at Ameritech we are very actively developing solutions that are workable, fair to customers, fair to the notion of full and complete competition, sustainable, and, perhaps most importantly, politically "doable" in this future environment.
So as I reflect on some of the issues discussed earlier today, I will try to give you Ameritech's view on what needs to be done to preserve the essential components of universal service in the fully competitive environment that is upon us.
There seems to be a general understanding and appreciation that our current universal service policies in this country are the result of both rational economic decisions and the very heavy influence of political processes.
As a provider, there has been an economic incentive for my company to maintain and increase subscribership because doing so increases the value we provide to all customers. The means for enhancing subscribership include providing assistance to low-income customers, customers residing in areas that are costly to serve, and customers with special needs, such as the hearing impaired. This assistance could take the form of reductions in monthly rates or non-recurring charges, more lenient deposit requirements or past due bill payment arrangements, free access to services that help control costs, such as toll blocking services, and better communications and accessibility.
Providing special assistance to these types of customers not only has an underlying economic rational, but also aligns well with the expectations of the political process -- at least as long as any resultant subsidies are implicit, or hidden from widespread public scrutiny.
Unfortunately, however, the influence of political processes has expanded the goals inherent in our current universal service policy well beyond the realm of economically justifiable objectives. The implicit goals of keeping all residential rates as low-priced as possible, regardless of the impact on rates charged to other customers and keeping rates averaged no matter what the underlying cost differences might be have resulted in major pricing anomalies. Current prices are far different from what would have evolved under market conditions free from these political influences.
Businesses have been required to pay far more than a market based price so that residential services could be priced low. Urban subscribers have been asked to pay prices that are well above cost so that service to their sometimes more affluent suburban and rural counterparts could be subsidized. And users of so-called discretionary services such as toll and special features have paid large premiums in order to fund below market prices for so-called essential basic services.
While the manipulation of prices has been the most obvious tool used by regulators to achieve the full breadth of politically influenced universal service goals, other regulatory actions have also had significant impacts. For example, the rather predictable regulatory practice of consistently underestimating the true economic depreciation that was occurring on in-service assets provided an obscure way to keep overall prices lower in the short run. Subsidies were generated for current customers, to be paid for by future customers. In another vein, regulators imposed "readiness to serve" requirements and associated penalties for noncompliance that gave providers incentives to over-estimate how many facilities were required to serve newly developing areas. Such requirements ensured that no customer ever had to wait very long to be connected to the network, but also imposed significant, hidden costs on all customers.
There also seems to be a general recognition that the mechanisms which were developed over time to carry out these universal service policies are ones which could only have been successful, or really have even been contemplated, in the closed system of local telephone service monopolies that characterized our industry for many decades.
As an aside, this premise is strongly supported by anecdotal evidence gathered from individuals recently exposed to the vagaries of pricing in our industry. Ameritech, for example, has recently hired many new managers from unrelated competitive industries to build the marketing and customer service skills that are required as competition enters our markets. These new managers are absolutely amazed once they come to understand our current system of price subsidies and cost shifting, for it resembles nothing they have experienced in the competitive industries from whence they came.
The closed system of monopoly allowed regulators to both manipulate price structures, distort the true economic costs of capital, impose non-economic legal requirements on providers and, at the same time, keep companies on a sound financial footing to fulfill legal mandates and attract the investor capital necessary to keep pace with growth and the rapid pace of technical change. The financial safety net extended to providers in this monopoly environment made them willing, albeit in many cases somewhat reluctant, partners with regulators in carrying out the political agenda.
But the closed system of the monopoly of local providers is no longer a reality. At the fringes, it has been gone for a long time -- ever since the ability to at least partially bypass the networks of the local providers, with private microwave systems or fiber optic networks built by competitive access providers, became a reality for large customers over a decade ago. And now the local monopoly is being attacked at its core as multiple providers are being authorized to provide a full range of competitive local services.
One thing that is for sure is that the mechanisms designed to promote and perpetuate universal service goals in the old days of a monopoly system are simply not sustainable in the new, full-blown competitive environment. Business customers will not voluntarily continue to pay an implicit tax to benefit residential customers if they can avoid that tax by giving their business to an alternative provider. Similarly, urban customers, who will surely be the first beneficiaries of competitive entry, cannot be expected to voluntarily continue to subsidize the high costs of suburban and rural areas.
So, once full competition becomes a reality the current universal service system begins to rapidly unravel. Does that mean that we must abandon our commitment to universal service as we embrace competition in our industry?
No, but it does mean that there needs to be a complete revamping of the current system of implicit subsidies and unilaterally imposed requirements, evolving to a new system based on explicit assistance, competitively neutral funding mechanisms, and symmetrical application of regulation. There should also be a comprehensive review and assessment of the universal service goals which evolved during the decades of a closed monopoly system, leading to revised, streamlined goals appropriate for a competitive industry and a transition plan for moving from where we are today to what is needed in the future.
It is incumbent upon regulators and government policy makers to reach these important policy decisions and communicate them to all industry participants early on in the process of opening local markets to competition. Failure to do so is likely to create misleading incentives for new participants, resulting in inefficient entry and wasted investments. And introducing local competition without a viable long term universal service plan -- one that both reassesses the goals and revamps the system to achieve the goals in a competitively neutral manner -- is likely to be strongly resisted by even the most progressive incumbent providers leading to gridlock and unnecessary delay in bringing the full benefits of competition to customers.
Let us look more closely at the need to comprehensively review and assess the universal service goals that have evolved over the last several decades. I believe this requires a three step approach, starting with the process of clearly articulating each and every goal which has guided past actions. Clarifying the difference between a goal and the means of achieving the goal is important. For example, is rate averaging the goal, or is it simply a traditional mechanism used in the past to achieve the goal of reasonable prices?
Next comes the step of assessing which goals will continue to require regulatory intervention. The entry of competition into local telephone markets will bring about a marketplace discipline that may supplant the need for regulators to mandate certain practices. For example, I believe that the widespread practice of mandating the availability of flat rate local calling service will no longer be necessary when competitors begin vying for customer business, for to succeed in the marketplace firms will have to offer service packages that fulfill customer needs.
The last step is the most difficult part -- taking each of the remaining historical goals and making an evaluation of whether the future benefits outweigh the costs of regulatory intervention. This is a difficult step to acknowledge for the traditional regulatory mindset, for it requires tacit recognition of the principle that there is no such thing as a free lunch. But it is a step that must and should be taken.
From my vantage point, I believe that, done properly, assessing each historical goal from a cost/benefit standpoint is likely to result in a major scaling back of traditional universal service objectives. On the one hand I believe the goal of maintaining and perhaps even increasing subscribership is likely to survive, for if assistance is appropriately targeted to need this goal can be achieved at a relatively low cost. But the achievement of most other goals probably comes at far too large a cost, and studies abound that estimate the overall benefits to be realized by liberating this increasingly important segment of our economy from the burden of obtrusive government oversight to the discipline of the competitive marketplace.
This scaling back of traditional universal service goals may not be as politically difficult as it may seem. Experiences in other states can be enlightening. During the 1980s, for example, Illinois went through a major transformation of its universal service goals. The principle of rate averaging was basically thrown out the window, and the historical subsidy flows that I described earlier were scaled back considerably. Customers in higher cost suburban areas were asked to pay higher prices, and customers in even higher cost rural areas were asked to pay even higher prices. Prices in urban areas, on the other hand, were reduced. The prices for making a toll call were aligned with the prices for making local calls. And the disparity between business rates and residential rates was dramatically reduced.
There was no measurable change in subscribership. There was hardly even any negative reaction to these dramatic changes. Sure, a few groups purporting to represent consumers squawked, but very few customers complained. There was virtually no political fallout. And on the positive side, these changes have permitted Illinois to remain an overall low price leader, and they have paved the way for Illinois to be one of the first test beds for the efficient introduction of competition.
I am optimistic that other policy makers are beginning to see the value of scaling back government-imposed universal service goals in these emerging competitive markets. In Michigan, for example, recently enacted telecommunications law mandates the rebalancing of rates so that by the year 2000 no service can be priced below its economic cost. The new Michigan law also specifically permits rate deaveraging. In Michigan, policy makers evidently believe that eliminating implicit subsidies is the best way to evolve to a fully competitive market.
And in both Illinois and Michigan, policy makers wisely decided to adopt three to five year transition plans for phasing in these changes, giving customers time to understand the impacts and make necessary adjustments.
What remains after this process of thoroughly reviewing and assessing historical universal service goals is the need to develop long term sustainable processes to achieve the (hopefully) scaled back list of new objectives. Transitional issues associated with migrating to the new universal service goals must also be dealt with. This requires explicitly identifying the subsidies that will be retained, developing competitively neutral mechanisms for funding these subsidies, and symmetrically applying regulation to all providers.
Ameritech believes that avoiding asymmetrical regulation of providers is a key to the sustainability of any universal service goals. Asymmetrical regulation encourages cream-skimming, or the selective provisioning of service to more highly profitable customers, and handicaps the ability of incumbents to respond to market forces. Left in this position, the ability of incumbents to continue to meet their "carrier of last resort" obligation is put in severe jeopardy.
Achieving symmetrical regulation can mean either subjecting new providers to the same rules and obligations of existing providers or relieving existing providers of the same. Practically, a balance of both approaches is required.
There will also be situations where neither approach is viable in the short run. For example, current regulations require many incumbent providers to offer below cost service to a large number of customers. As another example, incumbent providers are typically saddled with "carrier of last resort" obligations. In situations such as these where, at least in the short run, it is neither feasible to relieve the incumbent of the obligation nor tenable to impose a similar obligation on new providers, transitional mechanisms are required to maintain competitive balance.
In Ohio we have proposed a transitional mechanism to deal with three such issues. First, the aggregate amount by which costs exceed revenues for all subsidized Ameritech customers would be funded equally by all providers, in proportion to revenues. Determining the amount to be funded requires a very disaggregated analysis of customer revenues and specific costs.
Second, the aggregate amount by which Ameritech's capital assets have been under-depreciated in the past would be amortized over several years and, again, funded equally by all providers in proportion to revenues.
Third, the annual costs to Ameritech of fulfilling its asymmetric carrier of last resort obligations would be quantified and funded equally by all providers.
This proposal, along with several others, is currently being considered by the Ohio Commission.
Ameritech has been a national leader in developing and advocating comprehensive plans for the introduction of competition that seek to ensure universal service goals are not completely lost in the rush to make local competition a reality. Through groundbreaking proposals such as our regional Customers First Plan and individual state initiatives, I believe our efforts in this area have helped draw attention to the intricate interrelationships among all of the various initiatives being considered by policy makers.
The resolution of each of the many issues being teed up in our industry today -- including complex proposals to unbundle network components and offer wholesale discounts to resellers -- will have important implications for the sustainability of universal service objectives going forward. It is critical for policy makers to integrate the resolution of all of these issues, and resist the temptation to resolve them on a piecemeal basis.
In summary, I'd like to reiterate three key points I've made. First, let us not fool ourselves into thinking that the current processes for achieving universal service goals can be sustained in the new competitive environment. They clearly cannot.
Second, let us be open minded about fundamentally rethinking current universal service policies to focus solely on maintaining and increasing subscribership. Major reform is the easiest and, in the long run, may be the least painful means of ensuring the rapid introduction of competitive benefits throughout all of our markets.
Third, let us ensure that the processes established for achieving true universal service objectives in the future are sustainable by designing rules which are not provider-dependent.
Thank you.
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Last updated: 9 December 1996 mkh